Summary of Report 02-021

February 2002

Report Number 02-021

The State Auditor's Office contracted with Independent Fiduciary Services, Inc. (IFS) to perform an independent evaluation of the Teacher Retirement System's (TRS) investment program and practices on behalf of the Legislative Audit Committee. IFS finds that, based on current requirements of state law, TRS investment program and practices are:

. . . well structured and managed in an effective and professional manner. TRS is a leader in the pension fund industry, and in many respects its investment program and processes are emblematic of "best practices" used by other large public pension funds. Compared to [IFS's previous 1996 report] the increased professionalism and preparedness of both the members of the Board of Trustees and the investment staff are impressive.

However, IFS believes that developments in the securities markets and accepted pension industry best practices are becoming increasingly out of sync with current Texas statutory and constitutional provisions. IFS does not identify any legal constraints that are harmful to TRS's investment program, but it does identify legal constraints that inhibit TRS's efforts to maximize investment returns, minimize risk, and operate efficiently. IFS's recommendations are built around the principle that the TRS Board of Trustees (Board), as the fiduciary responsible for the effective management of the TRS Trust Fund, should be given the freedom to manage its responsibility prudently according to its best judgment. This freedom of prudent action should be counterbalanced by a high degree of accountability.

IFS's key legislative recommendations are summarized as follows:

• Make explicit the TRS Board's ability to delegate investment authority to internal staff.
• Allow the Board to delegate investment authority to external managers when warranted, subject to strict fiduciary standards.
• Allow the Board to invest in any asset class, instrument, or strategy it deems prudent.
• Grant the Board budgetary, personnel, and procurement autonomy as it pertains to the investment program, while maintaining strict reporting and accountability to the Legislature.
• Offset increased Board autonomy by imposing the modern, prudent person standard of care.
• Use the principles imbedded in the Uniform Prudent Investor Act and the Uniform Management of Public Employees Retirement Systems Act.

Specifically, IFS states:

. . . TRS could further optimize its management effectiveness if legal constraints on Board authority regarding the investment program, budgetary process, procurement, and personnel matters were significantly eased or removed. . . . Reducing these constraints-while still retaining essential safeguards-could make an already well run and well organized pension fund even stronger, thus facilitating TRS's ability to meet the retirement needs of its beneficiaries while minimizing TRS's reliance on general revenue appropriations.

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